Why Dollar Tree is ditching $1 forever

(CNN) — Dollar Tree is throwing away those green “Everything’s $1” signs at stores, ditching the brand identity it created and stuck to devotedly for 35 years.

The chain said last week that it will permanently raise prices by 25% on the majority of its products. Dollar Tree has already made the change at some stores and will roll out the new prices to all of its nearly 8,000 US stores by the first quarter of next year. In addition to new signs at stores alerting customers of the change, Dollar Tree will run advertising and train store staff on how to handle customers confused about why prices aren’t $1 anymore.

Dollar Tree was the last of the major dollar store chains that actually sold stuff for $1 and was defined by its prices. In 2015, Dollar Tree boasted that it was “the nation’s leading operator of fixed-price point stores.”

So its move to walk away from that image was a significant shift for the company and a sign of how rising inflation and the supply chain crisis is pushing retailers to adjust long-running strategies.

Dollar Tree’s model may have worked over the past couple decades when inflation was practically nonexistent. But the $1 strategy didn’t work for the current moment. The company finally walked away from $1 because it was hurting business.

It’s not an entirely abrupt shift for Dollar Tree, however. In September, Dollar Tree said it planned to begin selling items at $1.25 and $1.50 at some stores for the first time. It also said it would add $3 and $5 items to 5,000 stores, expanding on a prior strategy.

“This is the appropriate time to shift away from the constraints of the $1 price point,” Dollar Tree CEO Michael Witynski said in a statement Tuesday, adding that it was a “monumental step” for the chain.

Here’s what drove Dollar Tree’s decision to abandon its $1 strategy for good.

Rising costs

Dollar Tree sells primarily low-margin consumables such as food and household staples, as well as toys, gifts and seasonal goods at small, no-frills stores.

Its business model relies on keeping a lid on costs for labor, domestic transportation, fuel, merchandise and ocean shipping — 40% of its products are imported from overseas.

It becomes more challenging for Dollar Tree and other low-cost stores to hold prices at a fixed level and maintain its profitability as everything becomes costlier.

Costs are spiking for businesses. The producer-price index, which measures the price manufacturers receive for their goods and services, jumped 0.6% last month from September and rose 8.6% annually, matching annual record highs, according to the latest Labor Department data.

This has crimped Dollar Tree’s profits and margins.

During Dollar Tree’s first three quarters of 2021, its profit margin dropped 1.5% from the same stretch last year. The drop was particularly steep last quarter, falling 4.7% percent to around 30% from the same quarter a year ago.

Dollar Tree said that its decision to raise prices permanently was “not a reaction to short-term” inflation, but the change will help Dollar Tree return to its typical profit margin of around 35% next year.

It will also help Dollar Tree offset rising costs.

Selling stuff for $1.25 will “enable us to mitigate historically high merchandising cost increases, including freight and distribution,” Witynski said on an earnings call Tuesday, as well as “wage increases.”

New products and sizes
When you can only sell stuff for $1, it limits the products you can make money on and the size and quality of your merchandise.

“How small does a package of laundry detergent need to get to be $1?” said David D’Arezzo, a former chief merchant at Dollar General and veteran retail executive.

Selling stuff strictly for $1 forced Dollar Tree to stop offering some “customer favorites,” the company said, particularly in packaged and frozen food and household essentials. This part of the business is crucial to Dollar Tree because customers visit stores most frequently to buy these items, not gifts and toys.

Raising prices will give Dollar Tree flexibility to reintroduce the items it stopped selling, expand its merchandise selection and bring in new products and sizes to draw customers, the company said.

The company could use a sales boost. Sales at stores open for at least one year grew 2.2% last year from the year prior and 1.7% during the first three quarters of 2021 — a much slower pace than rivals.

Dollar Tree did not respond to requests for comment on which particular products it plans to bring back.

Pressure from Wall Street

Dollar Tree has struggled since its purchase of Family Dollar in 2015 for $8.5 billion. Its stock price, sales and profit growth, and store openings have lagged behind Dollar General and other discount chains. The company is on its third CEO since 2015.

Dollar Tree’s woes have attracted scrutiny from investors arguing that its $1 strategy was too rigid and hampered the chain.

In 2019, an activist investor took a stake in the company and pressed Dollar Tree to abandon its $1 prices and also consider selling off Family Dollar. The activist ended its fight after Dollar Tree announced it planned to test higher prices.

But Wall Street’s pressure on Dollar Tree has returned.

A different activist investor recently built a stake in Dollar Tree and tapped a well-respected former Dollar General CEO to push for changes. Dollar Tree is open to listening to input from the activist and will evaluate any changes it proposed, CEO Witynski said last week.

One analyst said the presence of the activist investor accelerated Dollar Tree’s decision to end $1 prices.

“The pace of rollout, along with [the] engaged investor, Mantle Ridge, clearly suggests otherwise,” Kelly Bania, an analyst at BMO Capital Markets, said in a note to clients last week.

Customers are getting used to higher prices

Dollar Tree believes it now has room to increase prices thanks to rivals doing the same.

Dollar General, Family Dollar, 99 Cents Only and Dollarama in Canada have sold stuff for more than $1 for years. Five Below, the toy and game store that sells its stuff for — as its name suggests — under $5 broke its strategy in 2019 when it started selling some items for up to $10.

Discount retailers such as TJX and Costco have also raised prices recently without much resistance from shoppers, Chuck Grom, an analyst at Gordon Haskett Research Advisors, said in a note to clients last week.

Dollar Tree “likely has more ‘permission’ from its customer base today” to hike prices because of these companies’ moves, he said.

Dollar Tree is betting that customers won’t buy less than they did or switch to competitors because of its new $1.25 prices. The company has tested the new prices at stores and conducted surveys with customers to gauge their reaction.

“Our shoppers are responding favorably,” said Witynski from Dollar Tree, adding that shoppers are “seeing price increases across the market” and can still find cheaper products at Dollar Tree.

But there are major risks to walking away from a brand identity built over 35 years.

“I think it dilutes their message,” said David D’Arezzo, the former Dollar General executive.

D’Arezzo and others warn that shoppers tied to Dollar Tree’s $1 image could revolt and a competitor like Dollar General may move to undercut Dollar Tree by selling more stuff for a buck.

“This screams as not very smart,” said R5 Capital analyst Scott Mushkin. “They shot the brand.”